'Demonising traders won't stop new financial crisis alone'

Banking will suffer if reforms just "demonise" traders rather than address the fundamentals of what caused the financial crisis, the head of the City regulator has warned.

Lord Turner, chairman of the Financial Services Authority, stressed it was right to crack down on "absurd" bonuses but warned against "ill-designed policy".

He said in his Mansion House speech last night that mistakes in reform would be "a more powerful force for harm than individual greed and error".

However, he said recent Basel III banking rules to prevent a repeat of the financial crisis would be a major force for change. He defended the requirements announced this month to increase banks' capital reserves against critics suggesting they do not go far enough.

There have also been fears that the decision to more than double the amount of spare cash banks must hold on their balance sheets could damage lending and hold back economic recovery.

Lord Turner said: "If we were philosopher kings designing a banking system entirely anew for a greenfield economy, should we have set still higher capital ratios than in the Basel III regime? Yes I believe we should.

"But starting from where we actually are, the Basel III reforms will significantly improve the resilience of our banking systems without harming economic recovery."

He also praised the Government's plans to scrap the FSA to create two bodies and hand bank supervision powers to the Bank of England, saying they would improve regulation. He said the move would cause challenges but create a "new structure which works well".

The FSA is to split itself in two by next spring and within two years will become known as the Prudential Regulation Authority, which will be a subsidiary of the Bank of England, and a new regulator called the Consumer Protection and Markets Authority.

There will also be a Financial Policy Committee to help maintain financial stability by taking a top level view to identify and stamp out risks as they emerge - "to take away the punch bowl before the party gets out of hand," according to Lord Turner.

He said change was needed after regulators across the world failed to spot and prevent the causes of the banking meltdown.

Lord Turner stuck by his comments last year that risky financial products were "socially useless".

"There were some absurd bonuses for excessive risk taking: there was an explosion of exotic product development which last year I labelled as socially useless', a phrase from which I in no way draw back."

But he said "we need to move beyond the demonisation of overpaid traders" to ensure a similar banking crisis does not happen again.

Bank of England chief cashier Andrew Bailey, who has been appointed deputy chief executive of the incoming PRA, said at the banquet that in the run-up to the crisis, regulators forgot that maintaining financial stability was "a duty that we all owe to the public".

"The fact of the matter is that the public has every right to expect us to act in their interest", he said.

In his opening remarks, Lord Mayor of London Nick Anstee urged the Government to avoid splitting up the banks and any further taxes on bonuses.

His comments come ahead of a report on Friday from the Independent Banking Commission that will set out the focus of an investigation into whether or not to break up the big banks.